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Central banks starting to diverge?

• USD bounce. USD Index recouped yesterday’s post US Fed driven falls. Solid US data & developments in Europe weighed on the major European currencies.
• Dovish Europeans. No more members of the BoE are calling for rate hikes. The Swiss National Bank became the first G10 FX central bank to cut this cycle.
• AU jobs. Employment jumped & unemployment fell to a multi-month low. Supports our thinking the RBA will lag other central banks in the upcoming easing phase.

FX markets have been whipped around a bit over the past couple of sessions on the back of central bank announcements and economic data. Yesterday’s pullback in the USD index, largely stemming from the US Federal Reserve’s decision to play a straight bat and continue to forecast ~3 rate cuts this year, unwound overnight with weakness across the major European currencies the driver. EUR is down near where it was trading ahead of the Fed meeting (now ~$1.0860), GBP is lower after falling ~1% overnight, while USD/CHF fell 1.2%. NZD (now ~$0.6040) has also undergone a round trip with confirmation in yesterday’s Q4 GDP report the NZ economy had tipped back into recession dampening sentiment. The AUD has also slipped, but it has held up better (now ~$0.6570) with yesterday’s blowout Australian jobs report a supportive factor on the crosses (see below).

A relative ‘dovish’ turn by the Bank of England and a lukewarm set of UK business PMIs exerted downward pressure on UK bond yields and GBP. Notably, two members of the BoE policy committee that had been voting for rate hikes changed their call to ‘no change’ (this is the first time in nearly 3-years no member voted for a hike), and the Bank also noted that even if rates start to be lowered policy would still be ‘restrictive’. The BoE is moving towards an easing cycle. Odds of a BoE cut by June have lifted to ~50% with almost ~4 cuts factored in over H2. Elsewhere, the Swiss National Bank became the first G10 FX central bank to lower rates this cycle with a surprise 25bp cut announced. Actions by the central banks of small open economies like Switzerland that are more quickly impacted by unfolding global trends are often looked at as a guide to what the larger ones could do down the track.

Relative strength in the US economic data also gave the USD a helping hand as the US 2-year yield bucked the European trend and ticked up (+3bps to 4.64%). The US business PMIs remained in ‘expansionary’ territory, while there were modest positive surprises across existing home sales, the Philly Fed survey, and initial jobless claims. The combo of solid data and outlook for lower rates over the medium-term boosted equities, particularly in Europe. The EuroStoxx600 increased 0.9%, and the UK FTSE00 rose 1.9%. The US S&P500 nudged up ~0.3%, and in the process hit a new record high.

We think the USD may hold onto its gains against the European currencies into the end of the week. UK retail sales (6pm AEDT) are predicted to show a sizeable drop in February. If realised, this could reinforce BoE rate cut predictions. In Europe the German IFO (8pm AEDT) should show momentum remains sluggish. That said, comments by US Fed Chair Powell (12am AEDT) reiterating policy adjustments later this years remains the base case could work in the other direction.

AUD corner

The AUD gave back some of yesterday’s US Fed and Australian labour market inspired gains overnight. After rising to its highest level in a week (~$0.6635), the rebound in the USD due to the dovish turn by BoE and SNB and some better than anticipated US data (see above) has seen the AUD slip back to ~$0.6570. That said, the AUD outperformed on most of the major crosses as Australia’s relative economic strength and diverging expectations for the RBA and other central banks came through.

AUD/EUR is back up around ~0.6040, AUD/GBP is near a ~1-month high (now ~0.5190), and AUD/NZD has extended its recovery. At ~1.0870 AUD/NZD is ~2.9% above its late-February lows, with the bounce back over recent weeks in line with our thinking (see Market Musings: AUD/NZD bouncing back). Data released yesterday showed that the NZ economy moved back into ‘technical recession’ with GDP contracting for the second straight quarter (or the 4th in the past 5 quarters) as the RBNZ’s aggressive actions to bring down inflation continue to constrain activity. Markets are now assuming ~4 RBNZ rate cuts by next February, with the first move fully discounted by August.

By contrast, locally, the Australian jobs report blitzed analysts forecasts. After a couple of weak months employment surged ~116,500 in February. Full-time jobs rose strongly (+78,200), while the unemployment rate fell to 3.7% (its lowest since last September). As we had been flagging, in last two months figures there was a larger than usual number of people who were deemed unemployed but were waiting to start or return to work. This translated to a jump in the number of people employed in February. If you strip out the volatility in the monthly labour force lottery “trend” employment is running at ~27,000/mth. The labour market has softened from the excessive tightness from about a year ago, but conditions are still positive. Indeed, on net, things look to be tracking a little better than what the RBA is penciling in (see chart below).

The broader labour market picture and other forces like Australia’s slower moving wage dynamics, the income support set to flow from the stage 3 tax cuts, and indications China’s economy is starting to improve support our assessment that the RBA could lag other major central banks in terms of when it starts and how far it goes during the next global rate cutting cycle. This policy divergence should, over time, see shorter-dated yield differentials move in favour of a higher AUD and see it outperform other currencies like the EUR, GBP, and NZD.

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